"We look at mortgages as borrowing and mortgage payments as spending. Is this right?"
Many people quote Warren Buffet: “To acquire wealth, do not save what you have left after spending, but spend what is left after saving.”
That presumes that after essential spending there is enough left over to make the decision, do I spend or do I save? For many there is not very much left.
To enjoy retirement, we must have acquired wealth that can be converted into spending power. When we reach retirement, we must ensure we do not draw too much income that we outlive our savings.
To acquire the wealth that is needed to retire, if possible, we must cut down on our spending to make the necessary savings. Yet when we reach retirement, we cannot spend too much in case we run down that wealth too quickly.
If you associate spending with having fun, where is the fun in engaging with a financial adviser who is going to say you need to spend less whether you are a potential saver or have retired? It’s a little like being told you are enjoying life too much. That becomes worse when you have to pay for the privilege.
Much is written about the need for financial education. Being able to understand compound interest, asset allocations, risks and so forth, are not relevant to day to day life and many do not want that education. Is the education required just about the need to save and budget? For many that is not going to be their favourite learning subject.
So what alternative education is required?
We need to get away from this work to age 65, then enjoy a 20-year holiday that is retirement, scenario. I reduce my spending while I am young and active, to get to the retirement dream, but still don’t save enough. In accordance with that dream I stop work at 65 only to be told that I may live 35 years instead of 20; I therefore cannot spend as much as I would like to enjoy my remaining active years before my energy begins to decline. I could insure the longevity risk, but current annuity rates mean the income is not very attractive, reducing further the opportunity for spending in retirement.
We need to therefore redefine what retirement savings include. They are any wealth that can be used to generate income during retirement, including housing wealth. This education is important - how many people save into a workplace SAYE share save plan but sell the shares they have acquired as soon as the plan matures?
Attitudes to acquiring housing wealth also need to change. We look at mortgages as borrowing and mortgage payments as spending. Is this right? At the end of the day the house purchaser has acquired an asset. Yet contributions to a SAYE share save scheme or a pension are classed as savings. Surely the repayment element of a mortgage should be treated as savings. It is adding to the net wealth of the individual.
I would go further, the alternative to house purchase is renting. Recently Royal London estimated that to rent throughout retirement requires, on average, £180k more in pension savings than someone who owns their house outright. Mortgage payments could be viewed as contributing towards that £180k in pension savings.
While working, when considering retirement savings, an individual therefore has three options: to spend their disposable income, to save for a house or to save in a pension. The correct financial education will enable individuals to make the right choices in the right combinations for them.
If a person reaches retirement owning their own home, they have a valuable asset. Not only does it mean they do not have to pay rent but they could let out a room to generate further income or they could generate capital from which they can draw income by moving to a cheaper house. Alternatively, they can use an equity release plan to extract a lump sum or series of lump sums.
Because equity release is essentially a fixed-rate lifetime mortgage, many refer to it as borrowing. Technically it is. But is this the way to talk about equity release? Borrowing has connotations with taking on debt which to many can be off-putting.
If you sold the asset (house) and purchased a cheaper replacement asset you would have the capital. Equity release enables the individual to raise the capital without the inconvenience of moving house. Also, drawdown products enable smaller capital sums to be withdrawn over a period of time.
Although the equity release loan increases with interest until the capital sum is repaid, usually on death, most plans carry a no negative equity guarantee. This is the cost of the capital.
But a house move can also incur a capital cost. All other things being equal, the value of a house worth £400k in monetary terms will increase in value more than a house worth £300k. The difference is the cost to the estate of moving to a cheaper house.
In retirement we must accept that many will need to augment their pension savings by calling on their housing wealth. Again, we need financial education that enables the individual to make the correct choices for them and their families rather than promote one solution over another.